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Saturday, April 27, 2013

27/4/2013: Sunday Times : March 31, 2014

The first of three consecutive posts to update on my recent articles in press.

This is an unedited version of my Sunday Times article from March 31, 2013.

What a difference a week, let alone nine months, make.

Nine months ago, on June 29th, 2012, the eurozone leaders pledged "to break the links between the banks and the sovereign" prompting the Irish Government to call the results of the euro summit 'seismic' and ‘game-changing’.

Fast-forward nine months. The number of mortgages in arrears in Irish banks rose at an annualised rate of 25%, the amounts of arrears have been growing at 65%. The number of all mortgages either in arrears, or temporarily restructured and not in arrears, or in repossessions is up 23% per annum.

Deposits held in Irish ‘covered’ banks have fallen 13.9% between June 2012 and January 2013. In three months through January 2013 average levels of Irish residents' private sector deposits was down 2.34% on three months through June 2012, clocking annualised rate of decline of 4%. Over the same period of time, loans to Irish private sector fell 1.54% (annualised drop of 2.7%).

Smoothing out some of the monthly volatility, average ratio of private sector loans to deposits in the repaired Irish banking system rose from 145.8% in April-June 2012 to 147.0% in three months through January 2013.

Put simply, in the nine months since June 29th last year, the urgency of implementing the eurozone leaders' 'seismic' decisions on direct recapitalization of the banks and on examining Irish financial sector programme performance has been rising.

Yet, this week, in the wake of yet another crisis this time decimating the economy of Cyprus, a number of EU officials have clearly stated that the euro area main mechanism for funding any future bailouts - the European Stability Mechanism fund - will not be used for direct and/or retrospective recapitalization of the banks. The willingness to act is still wanting in Europe.

First, chief of the euro area finance ministers group, Jeroen Djisselbloem, opined that the ESM should never be used for direct capital supports to failing banks. Mr Djisselbloem went on to add that Cypriot deal, imposing forced bail-in of depositors and bondholders, is the template for future banks restructuring programmes. This pretty much rules out use of ESM to retroactively recapitalize Iriosh banks and take the burden of our past banks’ supports measures off the shoulders of the Irish taxpayers.

On foot of Mr Djisselbloem's comments, the EU Commission stated that it too hopes that direct recapitalisation of the banks via ESM will be avoided. In addition, the EU Internal Markets Commissioner Michel Barnier, while denying Mr Djisselbloem's claim that Cypriot 'deal' will serve as a future template for dealing with the banking crises, said that "Under the current legislation for bank resolution . . . it is not excluded that deposits over €100,000 could be instruments eligible for bail-in". Finnish Prime Minister Jyrki Katainen weighed in with his own assertion that the ESM should not be used to deal with the banking crises, especially in the case of legacy banks debts assumed. Klaus Regling, the head of the ESM, made a realistic assessment of the viability of the June 29, 2012 promises by stating that using ESM to directly recapitlise troubled banks will be politically impossible to achieve. German officials defined their position in forthcoming talks on ESM future as being consistent with excluding legacy banks debts from ESM scope.

All of this must have been a shocker to the Irish Government that presided over the Cypriot bailout deal structuring which has shut the door on our hopes for Europe to come through on June 2012 commitments. After last weekend, uniqueness of Ireland is surpassed by the uniqueness of Greece where sovereign bonds were thrown into the fire and Cyprus where depositors and bondholders were savaged and not a single cent of Troika money was allocated to support the banks recapitalisations.

The slavish conformity to the EU diktat that prompted the Irish Government to support disastrous application of the Troika programmes in Greece and Cyprus is now bearing its bitter fruit.

Which means that three years into what is termed by the Troika to be a 'successful adjustment programme', Ireland is now facing an old question: absent legacy banks debts restructuring, can we sustain the current fiscal path to debt stabilisation and avoid sovereign insolvency down the road?

Let’s look at the banking sector side of the problem.

Latest reports from the Irish banks show lower losses for 2012 compared to 2011, prompting many analysts and the Government to issue upbeat statements about the allegedly abating banking crisis. Such claims betray short foresight of our bankers and policymakers. Even according to the Central Bank stress tests from 2011, Irish banks are not expected to face the bulk of mortgages-related losses until 2015-2018. Latest data from CSO clearly shows that residential property prices across the nation were down for three months in a row through February. Prices have now fallen almost 23% since the original PCAR assessments were made. Even at the current levels, prices are still supported to the upside by the banks' inability to foreclose on defaulting mortgagees. Meanwhile, there are EUR45.3 billion worth of mortgages that are either in repossessions, in arrears or restructured and performing for now. Taken together, these facts mean that at current rates of decline in property values from PCAR valuations, we are already at the top of the envelope when it comes to banks ability to cover potential mortgages losses. Add to this the effect of increasing supply of distressed properties into the market and it is hard to see how current prices can remain flat or rise through 2014-2015.

All of the above suggests that before the first half of 2014 runs its course we are likely to see renewed concerns about banks capital levels starting to trickle into the media. Thereafter, the natural question will be who can shoulder any additional losses, given the entire Euro area banking system is moving toward higher capital ratios and quality overall. The answer to that is, of course, either the ESM or the Irish State. The former is being ruled out by the euro area core member states. The latter is already nearly insolvent as is.

The headwinds to Irish debt sustainability argument do not end with the mortgages saga.

Take a look at the economic growth dynamics. Back at the end of 2010, when Troika structured Irish ‘bailout’, our debt sustainability depended on the 2011-2015 forecast average annual growth at 2.68% for GDP. By Budget 2013 time, these expectations were scaled back to 1.76%, yet the Troika continued to claim that our Government debt is sustainable. To attain medium-term sustainability, defined as declining debt/GDP ratios, between 2013 and 2017, IMF estimates that to stay the course Ireland will require average nominal GDP growth of 3.9% annually. To satisfy IMF sustainability assumptions, Irish economy will have to grow at 4.5% on average in 2016-2017 to compensate for slower rates of growth forecast in 2013-2015. So far, in 2011-2012 recovery we managed to achieve average growth rate in nominal GDP of just under 2.25% - not even close to the average rates assumed by the IMF.

And the real challenge will come in 2015-2017 when we are likely to face sharp increases in mortgages-related losses. In other words, growth is expected to skyrocket just as banks and households will engage in massive mortgages defaults management exercise.

There are additional headwinds in the workings, relating to the shifting composition of our GDP in recent years. Between 2007 and 2012, ratio of services in our total exports rose from 44.8% to 51.2%, while trade balance in services went from EUR2.75bn deficit to EUR3.1bn surplus. Trade in services is both more imports-intensive (with each EUR1 in services imports associated with EUR1.03 of services exports, as opposed to EUR1 in goods imports associated with EUR1.73 in exports) and has lower impact on our real economy. Irish tax system permits more aggressive, near-zero taxation of services trade against higher effective taxation for goods trade. This implies that while services-exporting MNCs book vastly more revenue into Ireland, most of the money flows through our economy without having any tangible relationship to either employment here or value added or any other real economic activity. In recent years, a significant share of our already anemic growth came from activities that are basically-speaking pure accounting trick with no bearing on our economy’s capacity to sustain public debt levels we have. If this trend were to continue into 2017, we can see some 5-7 percent of our GDP shifting to services-related tax arbitrage activities.

Which, of course, would mean that the ‘sustainability’ levels of nominal growth mentioned above must be much higher in years to come to deliver real effect on our government debt mountain.

Take these headwinds together and there is a reasonable chance that Ireland will find itself at the point of yet another fiscal crisis with reigniting underlying banking and economic crises. Far from certainty, this high-impact possibility warrants some serious consideration in the halls of power. Maybe, continuing to sit on our hands and wait until the euro area acts upon its past promises is not good enough? Is it time we start building a coalition of the states willing to tackle the Northern Core States’ diktat over the ESM and banks rescue policies?

Box-out:

Following the High Court judgment in the case involving rent review for Bewley’s Café on Dublin’s once swanky now increasingly dilapidated Grafton Street, one of the premier commercial real estate brokerages issued a note to its clients touching upon the expected or potential fallout from the case. The note mentions the stress the case might be causing many landlords sitting on ‘upward only rent review’ contracts and goes on to decry the possibility that with the Court’s decision in some cases rents might now revert to open market valuations. One does not need a better proof than this that Irish domestic sectors are nowhere near regaining any serious competitiveness. Instead of embracing self-correcting supply-demand reflecting market pricing, Irish domestic enterprises still seek protection and circumvention of the market forces to extract rents out of their customers. That’s one hell of a ‘the best small country to do business in’ culture, folks.

Disclaimer

This blog represents my personal views and is not reflective of the views or opinions held by any company, contractor, client or employer I work for currently or have worked for in the past. These views are not an endorsement to take any action in the markets or of any political position, figures or parties.

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